NBFC in India and Nidhi companies are seen to be functioning at larger and smaller platforms re...
Non-convertible Debentures or NCDs are a popular method of raising funds for the NBFCs. The majority of borrowers in the NCD market are from the NBFC segment. Muthoot Finance, Indiabulls Housing Finance, M&M Financial Services, Edelweiss Housing Finance, Diwan Housing Finance and SREI Infrastructure Finance are some of the well-known names raising funds through non-convertible debentures (NCDs).
The Reserve Bank of India (RBI) has tightened the guidelines for non-convertible debentures (NCDs) issued by NBFC. Many savvy investors choose to lock their funds in the non-convertible debentures issued by NBFC. In NCDs, the investors can lock their funds for a longer period of time at a profitable rate of interest.
Non-Banking Financial Companies or NBFCs raise money by way of issuance of capital or debt securities, including debentures through public issue or private placement. Hence, a substantial increase in borrowings of NBFCs has been witnessed through the issue of debentures major being on private placement basis.
The major benefits for investors in the Non-convertible debentures (NCD) issued by NBFC are:
Non Convertible Debentures (NCD) issued by NBFCs usually pays interest at the rate of 150-175 basis points much higher than what banks pay on their Fixed Deposits. Since many of the NBFCs issuing these NCDs are reputed as well as, well-capitalized, there is not much risk in for investors in investing in them. Apart from these, the fact that the NCDs issued by NBFC are closely regulated by the Reserve Bank of India (RBI) is a positive feature for the investors. The interest rates keep on fluctuating on other investments, hence in these circumstances, the NCDs offers a good instrument to lock the returns for a longer period of time.
Apart from locking at higher rates, there is another advantage in making investments in NCDs issued by NBFC. In case the rates depreciate from 25-50 basis points from the current levels, then the investor enjoys capital appreciation on the NCDs, which is apparent in their market price.
The debentures normally have got first charge or second charge on the assets of the issuer. Hence they are secured and typically safe as compared to other forms of investment. This provides an added advantage along with the higher rates of return and the prospects of capital appreciation.
Investors must be cautious regarding the risks associated with the NCDs issued by NBFC before committing funds to them. Some of the risks are enumerated below:
The Features of NCDs issued by NBFC have been explained below:
The tax implications of the investor on the Non-Convertible Debentures (NCDs) issued by NBFC depends on the tax bracket of the investor. In case if the NCDs are sold within a year or less than a year, the STCG will be applicable as per the income tax slab rate of the investor. In case, the NCDs are sold after one year, or before the date of its maturity, LTCG will be applicable at the rate of 20% with indexation.
The credit rating agencies such as CARE, CRISIL etc. rank the NBFCs. The basic purpose of this rating is to determine the potential of a company. If a company gets a higher credit rating, then it means that the company has the ability to fulfil the credit obligations. However, a low credit rating would mean that higher risks are involved in the company. In case any issuing company does not make payments, then the rating agencies give them lesser ranking.
The Non- convertible debentures (NCDs) issued by NBFC offer a high-interest rate. The interest rate usually ranges from 8% to 12%. The interest payouts are calculated either monthly, quarterly, half-yearly or annually. Cumulative payout option is also offered by NCDs.
The process for issuing NCDs has been mentioned below:
Section 42 – Offer or invitation for subscription of securities on private placement and
Rule 14 of Companies (Prospectus and Allotment of Securities) Rules, 2014 dealing with Private Placement
According to Section 42 of the Act read along with Rule 14 provides for:
However, the Revised Guidelines have categorized the issue of the private placement of NCDs in two categories
Under the revised guidelines, minimum investment aligned with Companies Act, 2013 to be Rs. 20,000.
Section 71 of Companies Act, 2013 read with Rule 18 specifies the provision for the tenure of secured debentures,
As per Section 71(4), every company issuing debentures must create a debenture redemption reserve (“DRR”) account from the profits of the company which is available for payment of dividend. The amount that is credited to such account shall be utilized only for the purpose of redemption of such debentures.
Note: However, according to Rule 18(7) (b) (ii) of Companies (Share Capital and Debentures) Rules, 2014, no DRR needs to be maintained for privately placed debentures by NBFCs.
Section 77 of the Act, 2013 requires registration of charges.
Section 77 of the Act, 2013 provides that every company creating a charge on its property /assets /any of its undertakings, whether tangible or otherwise, must register the particulars of the charge with the Registrar within thirty days the creation of the property.
For Category A -it is compulsory for non-convertible debenture to be fully secured in favour of subscribers.
For Category B -The issuer has the option to create security in favour of its subscribers.
As per the terms of NBFCs (Acceptance of Public Deposit) Directions, 1998-the debentures must be secured by mortgage of immovable property /any other asset of the issuer company. Creation of security by way of mortgage of immovable property will require registration under this section.
SEBI (Issue and Listing of Debt Securities) Regulations, 2008
The regulations of SEBI here apply to:
(a)The public issue of debt securities.
(b) The listing of debt securities issued through public issue or on private placement basis on a recognized stock exchange.
Hence, these regulations will not be applicable to privately placed debentures unless the issuer is to get the listing of such debentures.
These regulations regulate the issue of convertible debentures on a preferential basis by listed NBFCs.
The Revised Guidelines
From February 20, 2015, onwards, NCDs issued by NBFCs any – whether it is public or private/ listed or unlisted, on a privately placed basis, are governed by the revised Guidelines and provisions of the same.
Directions Issued by Reserve Bank on Non-Convertible Debentures
The Directions issued here will be applicable to Non-Convertible Debenture (NCD) by including NBFCs with original or initial maturity up to one year and issued by way of the private placement.
RBI through its notification on February 20, 2015, issued the guidelines on Private Placement of NCDs having a maturity of more than 1 year by the NBFCs.
It is not applicable to tax-exempt bonds offered by NBFC.
The NBFCs formulate a Board approved policy for resource planning/ covering the planning perspective and periodicity of the private placement.
RBI has specified the guidelines majorly for issuance of a private placement of NCDs of 2 categories:
Organizations rely on raising funds using NCDs only to meet a specific business purpose. They must provide clarity on the matter where and how the money will get invested. Investments made across various firms can reduce the risk considerably. NCDs in NBFC provide a better rate of interest so it can be profitable in the long run to make an investment there. The perfect time for the selling of the NCDs is when the interest is due. It is the prime trading for non-convertible debentures. You can make a good amount of money from there.
See Our Recommendation: What is Issue of Debentures in India.